Fractional Reserve Research Articles

ON THE WELFARE PROPERTIES OF FRACTIONAL RESERVE BANKING

Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long-term) investment opportunities, and the difficulties associated with it, such as the risk of insolvency for each bank and the associated losses to bank liability holders. I show that a specific banking arrangement (a joint-liability scheme) provides an effective mechanism for ensuring the ex post transfer of reserves from liquid banks to illiquid banks, so it is possible to select a socially efficient reserve ratio in the banking system that preserves the safety of bank liabilities as a store of value and maximizes the rate of return paid to bank liability holders.

Konsep Uang Islam: Antara Uang Komoditas atau Uang Fiat

Recent monetary crises have brought back the interest of scholars especially Muslim scholars to re-evaluate the current fiat monetary system. A group of Muslim economists believe that the source of problems is a form of fiat money. However, a larger group of Muslim economists prefer to set fiat money according to the rules of Sharia. This paper attempts to discuss the opinion of these two groups, so then offers the concept of money in Islam. The first group argue that the fiat money creates a seigniorage which is the cause of inflation, inequity of wealth distribution and monetary and financial crisis. Fiat money is also the soul of banking fractional reserve system which leads to the problem of inflation, business cycles and injustice distribution of wealth. Lastly, fiat money sytem with interest result in an inflationary economy. Besides these three, there is a belief that the money according to Islam must be commodity money. The second group counter that the strict rules for monetary management is proved to minimize the use of seigniorage so that inflation can be controlled. In fact, the fiat money and fractional reserve system support economic expansion so that the community can enjoy the economic growth. Furthermore, the business cycle is not just happening on a fiat money system but also a part of the commodity money system. Indeed, money in Islam must be a commodity is not agreed by the majority of fiqh scholars. However, in the context of international currency, the issue of injustice and the causes of the crisis becomes challenging issue. The first group propose to change international currency to commodity money, while the second group offers a monetary union as in the case of Europe. Finally, the concept of money is not about the form of money, but rather whether the money can be a just medium of exchange and measure of value for the goods and services.

Determining the Real Causes of Financial Crisis in Islamic Economic Perspective: ANP Approach

Objective – The purpose of this study is to determine the real causes of financial crisis from Islamic economic perspective. Methods - This study applies Analytic Network Process (ANP) to determine the real causes of financial crisis from Islamic economic perspective to be able to formulate the real solutions to end financial crisis. Results - The ANP results show that the real causes of financial crisis from Islamic economic perspective are Social Instability (EXTERNAL FACTOR), Speculation (MISBEHAVIOR), Ineffective Fiscal System (UNSUSTAINABLE FISCAL SYSTEM), Hedonism (MISBEHAVIOR), Fractional Reserve Banking System (UNSTABLE MONETARY SYSTEM), Political Instability (EXTERNAL FACTOR), Corruption (POOR GOVERNANCE), Interest Rate (UNSTABLE MONETARY SYSTEM), Fiat Money (UNSTABLE MONETARY SYSTEM), and the Wrong Man in the Wrong Place (POOR GOVERNANCE). These main real causes should be removed gradually in order to systematically and gradually improve the stability of financial system so that financial crisis will not reappear again and again in the future. Conclusions - Financial crisis would not happen under Islamic economic system if all Allah’s laws in financial dealings were followed. Financial crisis in conventional economic system could be prevented or lessened by gradually adopting Islamic economic and finance laws and regulations, partly or fully, especially the main pillars of Islamic financial system, namely the prohibition of ribā (usury or interest), prohibition of maysir (gambling and game of chance or speculation) and prohibition of gharar (excessive uncertainty), in their many forms.

Ecumenical Chronicle

Ecumenical Chronicle

Monetary Developments and Transmission in the Euro Area

Since the launch of the European Economic and Monetary Union (EMU) in January 1999 till today in 2015, the Euro has ascended to become the second largest reference currency in the world. With about €1.6 trillion of currency in circulation, it is at present even positioned above the US dollar with €1.3 trillion. The Eurosystem now comprises 19 EU countries with about 340 million people and inherits an outstanding role for the economy of the EMU, world trade, and international finance. Despite its importance, a recent independent empirical review that conclusively analyzes all key factors and efficiencies remains much obsolete. Thus, this research and review set‘s out to empirically-theoretically compile the last 16 years of the EMU with a focus on monetary developments, functioning of monetary transmission channels (MTCs) and mechanisms, as well as the performance of the Eurosystem and its ECB governed monetary policies (MP). For the first time, it reviews a complete set of 16 MTCs and systematically evaluates the functioning of the Eurosystem and its role for the real economy and its people. It finds a high loss of efficiency in all MTCs related to fractional reserve banking, excessive EU indebtedness, or legal frameworks such as MFI, financial, or equity law. Scientifically, based on all data and results, there is no way to reach a different conclusion and reminder that stresses the need, exigency and must to replace an old-fashioned reserve banking system by digital full-reserve banking via monetary reform at the earliest feasible date possible.

Rethinking banking. Debt discounting and the making of modern money as liquidity

ABSTRACTThe article radically challenges the conventional view of modern banking as financial intermediation and rejects the mutually related notion, firmly entrenched in both the mainstream and alternative imaginary, of fractional reserve banking. By contrast, it argues that modern banks are peculiar financiers which, far from banking other people's money, are originally and primarily involved with making money by creating a most fundamental institution of capitalism: liquidity. Crucially, central to the bank-engendered creation of liquidity is a negotiation of value that does not involve any formal lending of cash by a creditor – in fact, it does not require a creditor at all. Instead, it relies on a quid pro quo of debts performed by means of discounting whereby a regime of fluid property relations of mutual indebtedness, commonly known as debt finance, is established. In this regime of liquidity, money is constructed as entirely a debtors’ money: it is the outcome of a process of monetisation of bank debts entangled with a capitalisation of other people's debts.

A Critical Evaluation of Bail-Ins as Bank Recapitalisation Mechanisms

Many of the world’s developed economies have introduced, or are planning to introduce, bank bail-in regimes. Both the planned EU resolution regime and the European Stability Mechanism Treaty involve the participation of bank creditors in bearing the costs of bank recapitalization via the bail-in process as one of the (main) mechanisms for restoring a failing bank to health. There is a long list of actual or hypothetical advantages attached to bail-in centred bank recapitalizations. Most importantly the bail-in tool involves replacing the implicit public guarantee, on which fractional reserve banking has operated, with a system of private penalties. The bail-in tool may, indeed, be much superior in the case of idiosyncratic failure. Nonetheless, there is need for a closer examination of the bail-in process, if it is to become a successful substitute to the unpopular bailout approach. This paper discusses some of its key potential shortcomings. It explains why bail-in regimes will fail to eradicate the need for an injection of public funds where there is a threat of systemic collapse, because a number of banks have simultaneously entered into difficulties, or in the event of the failure of a large complex cross-border bank, except in those cases where failure was clearly idiosyncratic.

Giving Credit Where Credit is Due: The Benefits of Letting Banks Issue Money

Economists have long debated the relationship of bank to the business cycle. The attribution of economic cycles to the inherent of fractional-reserve has been advanced not only by Austrian scholars in the tradition of Murray Rothbard, but also by a number of prominent economists historically including Irving Fisher and University of Chicago icons like Frank Knight, Henry Simons, and a young Milton Friedman. The recent financial crisis has reignited these calls to abolish fractional reserve through narrow banking or sovereign money proposals. This paper rejects this notion and argues that the pyramid of credit plays a fundamental role not only in stabilizing economic activity but also in fostering economic development. The instability commonly attributed to pyramiding can be largely mitigated by policy changes far less drastic than the abolition of bank money, and any residual instability is almost certainly worth the dramatic benefits in normal times.

A lost century in economics: Three theories of banking and the conclusive evidence

How do banks operate and where does the money supply come from? The financial crisis has heightened awareness that these questions have been unduly neglected by many researchers. During the past century, three different theories of banking were dominant at different times: (1) The currently prevalent financial intermediation theory of banking says that banks collect deposits and then lend these out, just like other non-bank financial intermediaries. (2) The older fractional reserve theory of banking says that each individual bank is a financial intermediary without the power to create money, but the banking system collectively is able to create money through the process of ‘multiple deposit expansion’ (the ‘money multiplier’). (3) The credit creation theory of banking, predominant a century ago, does not consider banks as financial intermediaries that gather deposits to lend out, but instead argues that each individual bank creates credit and money newly when granting a bank loan. The theories differ in their accounting treatment of bank lending as well as in their policy implications. Since according to the dominant financial intermediation theory banks are virtually identical with other non-bank financial intermediaries, they are not usually included in the economic models used in economics or by central bankers. Moreover, the theory of banks as intermediaries provides the rationale for capital adequacy-based bank regulation. Should this theory not be correct, currently prevailing economics modelling and policy-making would be without empirical foundation. Despite the importance of this question, so far only one empirical test of the three theories has been reported in learned journals. This paper presents a second empirical test, using an alternative methodology, which allows control for all other factors. The financial intermediation and the fractional reserve theories of banking are rejected by the evidence. This finding throws doubt on the rationale for regulating bank capital adequacy to avoid banking crises, as the case study of Credit Suisse during the crisis illustrates. The finding indicates that advice to encourage developing countries to borrow from abroad is misguided. The question is considered why the economics profession has failed over most of the past century to make any progress concerning knowledge of the monetary system, and why it instead moved ever further away from the truth as already recognised by the credit creation theory well over a century ago. The role of conflicts of interest and interested parties in shaping the current bank-free academic consensus is discussed. A number of avenues for needed further research are indicated.

Kısmi Rezerv Bankacılığının Hukuk ve Ahlak Temelinden Yoksunluğu: Ekonomik Yansımalar ve Çözüm Önerileri

Kısmi Rezerv Bankacılığının Hukuk ve Ahlak Temelinden Yoksunluğu: Ekonomik Yansımalar ve Çözüm Önerileri

Fractional Reserve Banking and Price Stability: Evidence from Gulf Cooperation Council (GCC) Countries

This study aims at investigating the possible influence of the current money creation process applied by the commercial banks through the fractional reserve system on the overall prices stability in the Gulf Cooperation Council (GCC) countries. The study uses yearly data spanning from 2008 through 2013 for Qatar, Kuwait, Oman, Saudi Arabia and United Arab Emirates and applies panel regression analysis based on the pooled data set. The results indicate that neither outstanding deposits nor outstanding loans have a significant influence on general price levels.

The Gold Market and the Value of the U.S. Dollar

The aim of this research is to determine to what extent the price of gold is suppressed, thereby revealing an internal structural problem within the global monetary system. Historical manipulation could only have been done by controlling the value of money under a fractional reserve gold standard through the physical demand for, and supply of gold, in relation to official reserves held at a central bank. More recently, the price of gold is largely influenced through paper trades, as a function of the operation of the gold market involving gold derivatives, in conjunction with physical trades and changes in official reserves. This research adopts a qualitative interpretation and numerical analysis to analyze the extent of market concentration and price manipulation. Our findings reveal that the gold market is largely deterministic rather than stochastic in nature. It also reveals that markets are not only subject to a fractional reserve banking system, but also a fractional reserve gold market, highlighting systemic instability inherent within the modern monetary system, and especially the value of the U.S. dollar and related dollar denominated assets.

Critical Reflections on Bank Bail-ins

Many of the world’s developed economies have introduced, or are planning to introduce, bank bail-in regimes that involve the participation of bank creditors in bearing the costs of restoring a failing bank to health. There is a long list of actual or hypothetical advantages attached to the bail-in process. Therefore, there is a need for a closer examination of the bail-in process, if it is to become a successful substitute to the unpopular bailout approach. The bail-in tool involves replacing the implicit public guarantee, on which fractional reserve banking has operated, with a system of private penalties. The bail-in approach may, indeed, be much superior to bailouts in the case of idiosyncratic failure. In other cases, the bail-in process may entail important risks. The article provides a legal and economic analysis of some of the key potential risks bail-ins may entail both in the domestic and cross-border contexts. It explains why bail-in regimes will not eradicate the need for injection of public funds where there is a threat of systemic collapse, because a number of banks have simultaneously entered into difficulties, or in the event of the failure of a large complex cross-border bank, unless the failure was clearly idiosyncratic.

On the Welfare Properties of Fractional Reserve Banking

Superseded by Working Paper 15-20. Monetary economists have long recognized a tension between the benefits of fractional reserve banking, such as the ability to undertake more profitable (long-term) investment opportunities, and the difficulties associated with fractional reserve banking, such as the risk of insolvency for each bank. The goal of this paper is to show that a specific form of private bank coalition (a joint-liability arrangement) allows the members of the banking system to engage in fractional reserve banking in such a way that the solvency of each member bank is completely guaranteed. Under this arrangement, I show that a lower reserve ratio usually translates into a higher exchange value of bank liabilities, benefitting the consumers who use them as a means of payment.

Bank deposits, loans and redistribution of wealth in the case of an already adopted theoretical opinion

Money creation with fractional reserve banking is an already accepted theoretical position, designated as an operation after that the society is not richer but the economy is more liquid, because there is more money in circulation. Banks, by lending a portion of their deposits cause a process of creating of new deposits and thus increase the total money supply. Money, by definition, is a means for the exchange of goods and services, but after analysing the creation of money in the process of monetary multiplication, the question arises to which consequences this concept will lead. Therefore the theory of the money multiplier will be analysed in detail from the aspect of money demand, management of money supply and possible redistribution of wealth due to the existence of additional deposits.

On the Welfare Properties of Fractional Reserve Banking

On the Welfare Properties of Fractional Reserve Banking

Fractional flow reserve: Current applications and overview of the available data.

Flow fractional reserve (FFR) allows to evaluate the functional significance of coronary artery lesions, through the ratio of the mean coronary artery pressure after the stenosis to the mean aortic pressure during maximum hyperemia. The actual widely accepted cut-off value is 0.80. Below this value a coronary lesion is considered significant and therefore it requires invasive revascularization. Several studies [in particular Fractional Flow Reserve vs Angiography for Multivessel Evaluation 1 (FAME-1) and FAME-2] have shown the relationship between FFR measurement and hard end-points (death, myocardial infarction, and urgent revascularization). Consequently, FFR evaluation represents the cornerstone in the decision-making in intermediate coronary lesions. Recent studies paved the way for further applications of FFR evaluation in complex and tricky clinical settings. In this paper, we perform an overview of the data regarding contemporary application of FFR. In particular, we review the use of FFR in: left main intermediate stenoses, serial stenoses, evaluation after stenting, guidance in coronary artery bypass surgery, and acute coronary syndrome. All the data presented in our overview confirm the essential role of FFR assessment in the daily clinical practice. The shift from "operator-dependent" to "FFR-dependent" evaluation in intermediate coronary artery stenosis is of paramount importance in order to improve the prognosis of our patients, through the discrimination of the functional role of every single coronary stenosis.

On the Nature of Modern Money

Monetary theory texts teach that governments create money and control monetary policy. Researchers at the Bank of England, IMF and many others show that fractional reserve banking allows the private sector to create money. Most money currently in existence is created by the private sector, through the process of lending on interest. Thus creation of interest based debt is intimately connected to the process of money creation in the modern financial system. It should be obvious that giving the privilege of money creation to private parties motivated by the profit motive would lead to massive concentration of wealth. We provide historical evidence to show that this is indeed the case. This system of money creation is inherently unstable, and has led to numerous financial crises. Any reasonable evaluation of costs and benefits of the current system of money creation by private banks would lead to the conclusion that the costs have tremendously outweighed the benefits. Current efforts to adapt the Sharia’ (Islamic Law) to allow for modern banking are harmful, since modern banking itself is harmful to economies. The Chicago Plan was devised to return the privilege of money creation to the government where it properly belongs. We show that this plan can be adapted to create Islamic financial institutions which would be substantially different from current western financial institutions. These would be differentiated and specialized, and also provide real world services in addition to financial ones. We discuss the numerous advantages that adherence to Islamic principles would produce. Among these we would list elimination of banking crises, stabilization of economy, reduction of income inequalities, provision of economic justice, and greater investment in projects of high social benefit, rather than private benefits.

Can banks individually create money out of nothing? — The theories and the empirical evidence

This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing. The banking crisis has revived interest in this issue, but it had remained unsettled. Three hypotheses are recognised in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air".

Ethical Differences Between Loan Maturity Mismatching and Fractional Reserve Banking: A Natural Law Approach

In a number of recent articles, the debate on the ethics of fractional reserve “free” banking has been extended to loan maturity mismatching, specifically the banking practice of borrowing short and lending long. Barnett and Block (J Bus Ethics 88(4):711–716, 2009; 2010) claim the practice is illicit, because like fractional reserve banking it creates duplicate property titles. They argue there is a continuum in the time dimension between the two kinds of activities. Bagus and Howden (J Bus Ethics 90(3):399–406, 2009; 106(3):295–300, 2012a; Eur J Law Econ, 2012b; Bus Ethics 22(3):235–245, 2013) maintain that loan maturity mismatching does not create duplicate titles and is not illicit, and that from an economic and legal perspective there is no continuum with fractional reserve banking. Cachanosky (J Bus Ethics 104:219–221, 2011) and Evans (J Bus Ethics, 2013) enter the debate from the free-banking standpoint and view both practices as legitimate. In this paper, I agree with the conclusions of Bagus and Howden, but adopt a different approach to support this position. Using the title-transfer theory of contract, I demonstrate from first principles why loan maturity mismatching does not create duplicate property titles and is a legitimate practice. Employing this same theory, I then present a novel argument to show why the contractual arrangements found in fractional reserve banking are logically contradictory and illegitimate.